Dean Johns, CPA, CFP® discusses section 529 plan distributions. See the video here, or visit our YouTube channel for more video content from 9258 Wealth Management.

529 Plan Distributions & the Right Timing

Many of us have saved for years in 529 plans for our children’s education. Just like retirement accounts, eventually you will need to draw on those accounts to pay for college expenses. You can even withdraw funds to pay for private elementary, middle, and high school tuition. One consideration around distributions is the timing of them in comparison to when the expenses are actually incurred.

529 plans do not have withdrawal deadlines such as a specific age of the beneficiary or within a specified number of years after high school graduation. Funds can remain in a 529 plan indefinitely, and in some cases where over-funding has occurred, clients may keep the funds around for grandchildren. This is perfectly ok to do so.

However, the distribution timing rules do differ for Coverdell Education Savings Accounts (ESAs) and prepaid tuition plans. If you have these accounts, please review the related rules or contact us with questions.

It is important to keep in mind that 529 plan distributions must occur in the same tax year that the qualified expenses are incurred/paid. This is intended to avoid the abuse of letting tax-deferred funds grow for an extended period of time before taking a distribution. For example, one strategy that is NOT allowed is keeping funds in the account throughout the four years of college and then taking one big lump sum distribution in the fourth year for all previous qualified expenses. 

One side note is that this “delayed” distribution strategy does work for Health Savings Accounts (HSAs), but that is a topic for another article.

Families should pay particular attention to spring semester bills. The semester typically starts in January, but the bill may be due in December. You should take the distribution in the same tax year that you make the payment. Thus, if you make the payment in December, take the distribution in December. If you wait until January to pay the bill, take the distribution in January.

Taking distributions in the same tax year will allow you to match up the Form 1099-Q, which lists distributions in a tax year, with the Form 1099-T, which you receive from the college showing the amount of qualified education expenses paid during that tax year. It will alleviate issues or notices from the IRS that the amounts don’t match.

Some clients try to avoid this potential issue by having the college invoices paid directly from the 529 plan. Our concern with that approach is that sometimes there are expenses on the invoice that are not qualified education expenses. Thus, if you simply pay the entire invoice directly from the 529 plan, you could run into an issue of non-qualified distributions subject to penalties and taxes. We typically have clients pay the invoices directly, let us review the invoice for any non-qualified expenses, and then take an appropriate distribution from the 529 plan.

If you have any questions relating to 529 plans, please contact your financial advisor at 9258 Wealth Management by calling 513.791.9258!